Volume 6, Number 6, Page 2

Tax Reform in Colombia

By Michael Anderson and Jamie Vargas

At the end of last year, Colombia implemented new tax reform. The purpose of the new law (No. 488) is to raise badly needed tax revenue and reduce the fiscal deficit. The tax reform eliminates several income tax benefits seen as unjust or excessive, and greatly increases the number of products and services subject to VAT in Colombia. This article highlights some of the changes contained in the new law.

Foreign Investment Tax

Until 1998, the Colombian Tax Code provided tax-free treatment for profits derived from the sale of stock. The new law limits the exemption allowed for capital gains on the stock market. Tax exempt treatment for these gains was also eliminated January 1, 1999.

The Colombian Tax Code exempts local profits that foreign investors reinvest in the country for more than 5 years from the 7 percent surtax, whether in the form of "income tax" (for companies) or "remittance tax" (for branches of foreign companies). The tax reform contains a succinct definition of "reinvestment in the country" for these purposes defined as "the simple fact of keeping the profits in the patrimony of the [local] business." The question then arises whether this is in fact the only qualifying form of reinvestment; or whether reinvesting the profits in a local venture other than that which generated the profit is still considered as valid reinvestment for these purposes. With regard to branches of foreign companies, by simply maintaining the profit in any registered offshore bank account they would be "keeping the profits in the patrimony of the business," provided of course the account belongs to the branch (before the enactment of the new tax law this form of deposit did not qualify as valid reinvestment in the country).

Under the new tax law, fees paid for technical assistance or technical services rendered by nonresident companies or individuals are subject to 10 percent withholding, whether rendered inside the country or abroad. Under the old rules, such services were subject to 35 percent withholding tax when rendered inside Colombia. This is good news, and the rule frees taxpayers from the temptation to artificially allocate the price of technical assistance or technical services to services supposedly rendered from abroad. (These services will, however, continue to be subject to VAT, in all cases where the recipient is based in the country).

Under the old rules, consulting services rendered from abroad by nonresident companies or individuals were not subject to withholding taxes (unless they were technical or technical assistance services); on the other hand, consulting services rendered in Colombia by the same were subject to a withholding tax of 39.55 percent. Beginning January 1999, consulting services rendered inside the country or abroad by nonresident companies or individuals are now subject to 10 percent withholding tax.

Consulting Services

Colombian law does not define "consulting services." According to the Colombian Civil Code, whenever the law does not define a word, the interpreter of the law should give the word its usual, natural, and generally accepted meaning.

Foreign Loans

Under the new law, interest paid on foreign loans obtained by trusts managed by local fiduciary companies does not generate Colombian source income and thus is not subject to withholding taxes, provided that the loan is obtained to finance activities important for local development--- which includes practically all commercial activities (mining and agriculture, manufacturing, general trade, and services included). This rule did not really add anything to existing law, but the clarification is helpful and should avoid unnecessary litigation with the tax office.

The so-called presumed income tax on gross assets is eliminated as of the year 2000.

Pension Funds

The amount of labor income that may be contributed to pension funds free of income tax and withholdings is raised to 30 percent of labor income (under the preexisting law, this cap was 20 percent).

Pension payments and other cash withdrawals from pension funds are generally freed from income taxes, so long as the relevant funds have been kept in the fund for at least five years.

Value Added Tax (VAT)

Besides reducing the general VAT rate to 15 percent beginning in November 1, 1999, the most notable feature of the bill is its extensive expansion of the number of products and services subject to VAT. Under the previous law, more than 400 different classes of products were not subject to the tax. The new law cuts that list down to around 80 classes, which basically comprise livestock and first-necessity goods and services (food and medi-cine).

Advertising services are now taxed, but at a lower 10 percent rate until the end of 2000. Local air tickets also are subject to VAT (also at a lower 10 percent rate) except in peak travel season.

International air tickets are subject to VAT, even if purchased outside Colombia. if the city of departure is in Colombia.

Michael Anderson and Jamie Vargas are attorneys with Baker and McKenzie in Bogota and Chicago respectively.